The Iowa Caucuses, dark horses and the mystery of crowds

The sun sets over a farm January 1, 2012 in Johnston, Iowa. (Win McNamee/GETTY IMAGES)

With less than 24 hours to go before the Iowa Caucuses, former Massachusetts governor Mitt Romney and Rep. Ron Paul (R-Texas) are are well positioned to finish first and second in the first voter test of the Republican field. That’s not just the consensus of pundits and armchair politicians — that’s the current outcome predicted by the Iowa Electronic Markets, perhaps the most avidly watched prediction market during any U.S. presidential election. Real traders with real money on the line, at the writing of this blog post, were giving Romney roughly an 86 percent probability, and Ron Paul around a 70 percent probability, of finishing in the top two when all the final results have been tallied by midnight.

Prediction markets, which burst into mainstream popularity after the release of James Surowiecki’s The Wisdom of Crowds, have become an increasingly sophisticated way to model the outcome of events when the range of possible outcomes is known. With less than 24 hours to go, the “crowd” appears to have written off Texas Governor Rick Perry and Rep. Michele Bachmann (R-Minn.) to the point where their contracts in the Iowa Electronic Markets are trading at close to zero. The crowd thinks that even former House speaker Newt Gingrich now has less than a 1 percent probability of finishing in the top two in Iowa — even after a surge in popularity at year-end.

The crowd may sometimes be mad and delusional, and the Iowa Electronic Markets do not always get it right. But what’s interesting is that the Republicans continue to shuffle through candidate after candidate, looking for someone who can beat Obama head-to-head. According to the crowd, none of the current Republican candidates — at least not anyone who’s currently in the field — can. The 2012 Presidential election may be one of those epic horse races where the pundits get it all wrong, and the crowd gets it all right. Will a dark horse candidate come out of nowhere to win the race at the end by a nose?